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Turnkey Development for Charter Schools in the District
Over the past few years, there has been an increase in demand for turnkey development solutions for charter schools. Two non-profits, Building Hope and Charter Schools Development Corporation (CSDC), both members of the FOCUS Real Estate Council, are providing turnkey development in Washington, D.C. FOCUS’ Alison Collier sat down with them to ask about this service.
FOCUS: What is Turnkey Development?
Turnkey Development is when a property developer provides a school the entire facility solution—the location of the site, the design of the school building, the construction, the furnishings, all of the approvals, and the financing. The school’s executive leadership or board members do not have to worry about managing the often complex development and financing process. The school is involved, to be sure. They provide the description of the program space needs and then the building is built to suit. However, at the end of the day, it is the responsibility of the developer to provide the facility ready for occupancy. The school has the option to lease the facility until such time it is ready and willing to buy the property from the developer. It is essentially a lease-to-own arrangement.
FOCUS: Why would a school want to use turnkey development?
There are a few reasons why this can be the right option for a school. The most common reason is that it is challenging for a charter school to qualify for financing. Again, this is more often true for newer schools, especially those that grow their enrollment over time. The school will not have enough enrollment or financial track record in its first few years of operations to independently qualify for financing. In the case of turnkey development, where the developer finances, owns, and leases the property to the school with an option-to-purchase, the developer’s balance sheet is at risk, not the school’s. The good turnkey developers can create a payment schedule that matches the growing enrollment—pay less in the early years and pay more when the enrollment matures. Many nonprofit turnkey developers can access low cost financing and pass those savings on to the school in the form of reduced rent. When the school has matured and can qualify for its own financing, it can buy the property from the developer. The second most common reason that property development is a time intensive activity that requires very specific skill sets and expertise. Most schools only go through the process once, so investing the time and energy into becoming facility experts when they should be focusing on running high performing schools is not always in the best interest of the school. Even with the support of all of the partners (architects, contractors, project managers), a school’s management team may find it does not have the capacity, or expertise, to take on the responsibility of delivering a facility for opening day. This often results in missed deadlines or cost overruns. This is most often true for newer schools and individual schools without a charter management organization (CMO). Some of the CMOs have the ability to hire this capacity internally, but even some of them have chosen to use a third party. They would rather spend their time focused on the incredibly difficult and important process of teaching and learning.
FOCUS: How is this different from what Building Hope and CSDC do?
It’s not different. Building Hope is best known for providing financing to schools. For the past decade, it has used its investments to provide low cost and often subordinate debt to make financings work. This unique ability has always differentiated Building Hope. However, a few people may remember that Building Hope’s very first two projects were turnkey development for Cesar Chavez PCS. One of them was the ground up construction of their Parkside campus and the other was a renovation of an existing building, so this is very much in Building Hope’s DNA. Those projects allowed Cesar Chavez to move into new facilities that they weren’t ready to finance back in 2004. The financing terms were so good that the school decided to continue to lease one building for another six years, until it purchased the building in 2010.
Turnkey development is also at the heart of the Charter School Incubator Initiative, Building Hope’s public-private partnership with OSSE. The Charter School Incubator Initiative projects differed from traditional turnkey projects in that the schools in these projects were not able to buy or assume the leases of the incubator buildings by right. However, as in turnkey developments, Building Hope managed the development of all 12 incubator buildings so far. This has been ideal for new and young schools to move in to space that is ready for use.
Turnkey development is the core of what CSDC does. CSDC is also known for the Building Block Fund, a national credit enhancement program. CSDC is the second largest recipient of credit enhancement funds from the federal government, and schools from around the country call CSDC to help with their financing. But their largest and most in-demand program for the past seven years has been their turnkey development program. In D.C., CSDC has developed for lease with option-to-purchase three charter school campuses, including one incubator location known as the Frum Center.
As nonprofits, both organizations have the mission to help charter schools grow and to serve students, especially those most in need. The two organizations have already created over 100,000 seats for students in high quality schools around the country—that’s more seats than most large school districts.
FOCUS: Should all schools choose turnkey development?
No, this isn’t a cure-all for every school. Some schools or school groups have strong balance sheets and can qualify for financing themselves. They also either have the internal staff to develop property themselves or they hire experienced development consultants to manage the development for them. They also may already own or have an interest in a piece of property and do not need a developer to find a site for them. They are well suited to manage the process of issuing Requests For Proposals for architects and contractors and participating in the selection process.
FOCUS: Are there examples of turnkey development in the District?
There are a handful of examples of successful turnkey development projects in Washington, D.C. CSDC has completed three projects. Building Hope has completed the two Cesar Chavez campuses, in addition to the facilities in the Incubator program. There have been one or two other organizations providing turnkey development as well. Rocketship is using turnkey development for their first campus that is due in a year or two.
FOCUS: Can you describe the process in detail?
Two specific examples are Washington Yu Ying PCS and Cesar Chavez PCS.
Washington Yu Ying opened in 2008 in an incubator facility developed, financed, owned, and leased by CSDC, commonly known as the Frum Center, to two start-up schools – Potomac Lighthouse and Washington Yu Ying. Potomac was the master tenant with the purchase option, while CSDC entered into a three year lease with Yu Ying. During that original short term lease, Yu Ying was able to gain a track record and stabilize enrollment and finances to set the stage for them to eventually move out of the start-up space into a new permanent home. Indicative of CSDC’s commitment to work with their charter school clients throughout their lifecycles, CSDC continued to be an integral part of the school’s development and financing of its permanent home. The school, creditworthy after leasing from CSDC for its first three years of operations, was able to qualify for independent financing and utilized CSDC’s Fee Developer Services program to develop their permanent home.
Building Hope has worked with Irasema Salcido and the Cesar Chavez Public Charter School for Public Policy since their move from the basement of a Safeway to the four campuses they now occupy. For their second campus, Building Hope identified a property in Ward 7 through a socially conscious real estate developer and friend of Joe Bruno. Building Hope hired the architect to design the 80,000 square foot school building for 700 students in middle and high school. It then hired the contractor to construct the property in four months to be ready by the beginning of the 2005 school year.
The total cost of the building was $15 million. Building Hope secured a $10 million loan from Bank of America and put up the other $5 million itself.
FOCUS: Who picks the architects and contractors?
The turnkey developer is responsible for selecting the vendors—the architect, the contractor, a project manager if needed. The developer issues the RFPs and invites the school to the interviews. While the final decision rests with the developer, most reputable turnkey developers will include school management in the selection process. It is important that the school management understand the reasons for selecting the vendors and ensures there are no philosophical differences with the vendor’s approach that would result in challenges down the road. At the end of the day, the developer is constructing buildings it expects the tenants to purchase. That is a strong incentive to make sure the schools have buy-in and ownership of the projects throughout the process.
FOCUS: How much does it cost?
The actual hard costs to develop a property are the same whether the school undertakes the project or a turnkey developer manages the project. The biggest differences are that with turnkey development the school does not need to come up with any equity upfront since the developer is the owner and borrower, and in the case of Building Hope & CSDC, the ability to lock in a fixed-price purchase option. These are huge benefits for new and growing schools that have yet to accumulate enough of a fund balance, or equity, for the down payment on a facility—typically between 15 and 25%. The turnkey developer should be able to drive the overall price lower because of their experience, especially in terms of minimizing change orders and value engineering.
The school will often pay a developers fee to the turnkey developer. This is in lieu of the school having to hire its own staff to manage the project, since it is difficult for a school to hire someone for a single project or two who would have as much experience as a turnkey developer. (For example, Building Hope and CSDC have developed over 40 charter school facilities.) This fee can range from 2.5% to 3% of the total project costs for a nonprofit developer depending on the complexity of the construction and the size of the project. Building Hope and CSDC offer schools the ability to finance this fee and pay it over time under the lease, which helps with cash flow management. For example, a portion of the fee may be financed up front, with the balance added to the purchase price and paid when the school exercises its purchase option. At that point in time, the school has an established track record, is independently creditworthy and can more easily absorb the fee. This flexibility and ability to qualify for lower cost financing is what we call the “nonprofit developer difference.”
The ability to buy the property at a later date at a fixed price allows the school to plan its financing needs into the future and build up the required equity. The turnkey developer often helps with the take-out financing package to ensure the school gets the best long term rates. The flexibility in the timing of the buy-out also allows the schools to lock in at the lowest financing rates it can get.
Charter Schools Development Corporation information is available at www.CSDC.org
Building Hope information is available at www.BuildingHope.org